National Institute of Economic and Social Research

Wednesday, 14 March 2012

Rejecting growth pessimism

Forecasts for the UK economy are grim. The Office of Budget Responsibility (OBR) predicts that, on current policies, output won't recover to its pre-crisis level until perhaps 2014 – no growth over six years. This will make this recovery far slower than that following the Great Depression, as shown in the National Institute of Economic and Social Research's famous chart here. Moreover, even in 2015,unemployment will still be well over 2 million.

What do policymakers propose to do about this? Not a lot. Remember, these are the official forecasts, taking account of policy. So instead of taking any substantive action, the rhetoric is of the inevitability of a slow recovery. The governor of the Bank of England says that "the path of recovery is likely to be arduous, long and uneven." Nick Clegg, using a similar metaphor, talked about a "long, hard, road ahead".

But this isn't about roads, it's about people. Unemployment, especially youth unemployment, has "scarring" effects; an individual experiencing a spell of unemployment earns less and is more likely to be out of work later in life. And already, unemployment is becoming entrenched: jobseeker's allowance is supposed to be, and until recently largely was, a short-term benefit for those who should be able to find work quickly. But the number claiming for more than a year has been shooting up – for young people, it has doubled. The long-term damage this will do to the UK economy and society is immense.

This economic masochism is unnecessary and damaging. The underlying health of the UK economy is much better than the forecasts suggest; and the scope for action is considerably greater. Over the past two decades – up to and including the recession – productivity grew faster in the UK than in any other G7 economy. While a small part of that reflects the growth of the financial sector, most was due to improvements in the UK labour market, a higher skilled workforce, and a more competitive economy. But the OBR is arguing that over the next two years, potential productivity will only grow at about half that rate, and that we will make up little or none of the output lost in the recession. This is a self-fulfilling prophecy: if we believe it, it will be true. But it doesn't have to be.

So what can and should the chancellor do in the budget? The first thing he should do is to explicitly disavow the pessimism of the OBR and the Bank of England about the potential of the UK economy to grow and create jobs without generating inflation. Of course, the chancellor must accept the OBR's verdict on the arithmetic. But that doesn't mean he should accept their growth pessimism. He should state explicitly that he does not accept that we are doomed to slow growth, or to unnecessarily high unemployment for the indefinite future – and that he intends to put us on a different track.

Three relatively straightforward measures could make a real difference. First, he should introduce a tax cut that would help low-paid workers and create jobs. A genuine stimulus would be, as the IFS has said: "Timely, targeted and temporary." Raising personal allowances, still less tinkering with the 50p rate or the pension contributions of the better-off, are not. An obvious candidate would be a large cut in national insurance contributions for young and low-paid workers, which could satisfy all three conditions (reintroducing the educational maintenance allowance, abolished at the wrong time for the wrong reasons, would also help).

Second, with long-term interest rates at historic lows, there has never been a better time to invest in Britain's creaking infrastructure. In thespending review, capital spending – as always – suffered most, with many projects assessed as having long-term benefits cancelled. All the Treasury needs to do is take them down off the shelf.

Third, the UK suffers from a structural shortage of housing supply. This has a number of economic impacts – none of them good. It pushes up prices, redistributes wealth from the poor and young to the old and rich, and reduces both labour mobility in the short term and social mobility in the long term. Both this government and the previous one tried to boost demand for housing through stamp duty holidays and other subsidies; this is precisely the wrong way round. Far better would be to subsidise house-building by helping social-housing providers to borrow and build.

But wouldn't all this run up against the OBR's arithmetic? The short answer is, no. The government's primary fiscal target is to balance the cyclically adjusted current budget five years in the future. So neither a genuinely "timely, targeted and temporary" tax cut, or an increase in capital spending, have any direct impact at all on the target. The chancellor cannot hide behind either his own targets or the OBR as an excuse for inaction.

In 1925, Winston Churchill expressed his dismay that policymakers seemed to be "perfectly happy with the spectacle of Britain possessing the finest credit in the world simultaneously with a million and a quarter unemployed". There is no need for us to make the same mistake.